In this paper, the authors separated the risk from uncertainty. This separations was treated as the criteria of deciding who is entrepreneur or non-entrepreneur. Under the conditions of uncertainty, entrepreneurs solve the problem of firms' decision rights and of residual claims so that they could organize a firm to facilitate the assembly and coordination of the resources needed to exploit a market opportunity (p. 777).
Even though managers or many people could use various ways to increase the certainty of the outcomes associated with making their decision, such as using the data on consumer preferences, "it will often the case that - even after all that can be done - the outcomes of decisions will often not be certain" (p. 778).
Thus, when exploiting a market opportunity, there often have two types: First, the risky investments. Furthermore, there were two conditions existed: (1) "when all possible future outcomes of exploiting that market opportunity are known at the time the decision is made; and (2) when the probability of each of these outcomes occurring is also known at the time a decision is made. The outcomes of these decisions are governed by well-defined probability distributions" (p. 778). Also, under these conditions, "as long as the discounted present value of the cash flows generated by making a risky investment in a market opportunity is positive, those seeking to maximize their economic wealth will have an incentive to make this investment" (p. 778).
Second, the uncertain investments. This is the situation where "the decision to invest in a market opportunity is uncertain when the possible outcomes of this decision and the probability of those outcomes are not known when a decision is made" (778). People are often so overconfident about themselves' anticipation to the result of decision that they underestimate the level of uncertainty in their environments.
All in all, when the outcomes of a decision are not certain, they are either risky or uncertain.
Under the conditions of uncertainty, the two currently dominate discussions of how firms are organized - that is, transactions cost economics and incomplete contract theory - could hardly work. In transactions cost economics, since there is a cost associated with using markets to govern certain economic exchanges, the hierarchical governance could address this issue by bringing a problematic exchange within the boundaries of a firm where a manager can monitor and control the behavior of all parties to that exchange. This process of reducing the treat of opportunism is known as "managerial fiat" (p. 780).
The reason why this hierarchy could work is based on the assumption that managerial fiat had sufficient information to manage an exchange in ways that are acceptable to all parties to that exchange. However, when the value of each party is unknown and the outcomes is unknown, such government to exploit opportunities might be ineffective.
In incomplete contract theory, it was suggested that "it is frequently not possible to write and enforce detailed and complete contracts to manage economic exchanges when those exchanges are initially conceived. In such settings, a firm emerges as an institutional framework where the rights to make specific decisions in an exchange are assigned to different parties to that exchange. The key decision rights are 'residual rights of control'" (p. 781).
However, when the information of who might benefit the most from an exchange is not known at the time when a firm is being organized under uncertainty, the people in the company cannot know who should control residual rights in that exchange.
To solve foregoing problem at the conditions of uncertainty, the authors argued several typologies:
First, Clan-based entrepreneurial firms. To make transaction-specific investments under uncertainty, the decision making in this firm would not be hierarchical, rather decision making would be more "democratic and consistent" with searching for a consensus among all those who have made specific investments in the firm. It should be emphasized that (1) the value of both productivity and value of an exchange may not be known, ex ante; and (2) an exchange only becomes possible if a clan already exists. People in clan-based entrepreneurial firms share all decision rights and residual claims, so that everyone is creating the value of firms and trusted by others. This process would bring decision-making leadership among all essential firm employees.
Second, Expert-based entrepreneurial firms. The decision of whether participating in the market opportunity exploitation is not dependent on the value pf people' opportunity, but on how they can use the assets they control in other economic settings. Thus, although the probability distribution of outcomes associated with making a specific investment may not be known, by examining the total value of the opportunity costs of parties to an exchange, it will be possible to identify who in an exchange has the strongest incentive to maximize the value of that exchange and who in an exchange should have the decision-making rights in that exchange (p. 785).
It should be emphasized that: (1) if the party have opportunity costs that are approximately equal in value, then these individuals will have difficult problems organizing a firm under uncertainty; and (2) the person with the most valuable opportunity costs should have decision-making rights of control in any firm that is organized - that is, they should be the "expert" in this expert-based entrepreneurial firm (p. 785).
Third, Charisma-based entrepreneurial firms. It is a sense that some individuals have of themselves of their vision of the future and of the inevitable success of their cause. Charismatic individuals can sometimes gather others around them in a form of hierarchical organization. In the extreme, the values, beliefs, and logic of subordinates are replaced by the vision of the charismatic leader. Thus, the firm will also be hierarchical.
In sum, basing on the distinction between risk and uncertainty, current transactions cost and incomplete contract theories apply quite well under conditions of risk; they must be extended and modified under conditions of uncertainty. Furthermore, these arguments help distinguish between entrepreneurial and non-entrepreneurial firms: entrepreneurial firms are organized under uncertainty, whose "primary purpose" is to solve transaction difficulties associated with the inability to know the value of an exchange at the time that exchange is commenced; non-entrepreneurial firms are organized under conditions of risk. The typology developed here showed that entrepreneurial firms could vary in some systematic ways.
Without these entrepreneurial firms, uncertainty is not likely to evolve into risk because there would be no coordinated resources brought together to try to exploit market opportunities. Without this initial coordination of resources, information about the probability distribution of outcomes associated with an exchange may not become known.
In the case where entrepreneurial firms could not transform themselves into non-entrepreneurial firms, the costs of renegotiating decision rights and residual claims may simply be too great to enable the exchanges around which a firm is organized to continue.
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